Charitable Choice: The Compassion Tax Credit

In the ongoing debate over welfare reform, an ambitious and innovative idea has recently garnered national attention. Often referred to as "charitable choice," the measure proposes to make welfare not simply taxpayer funded, but taxpayer controlled through a system of tax credits for charitable donations. Last year, Bob Dole included such a plan in his campaign platform.

An even bolder version of the charitable tax credit proposal has been offered by Beacon Hill Institute economists David G. Tuerck and William F. O’Brien, Jr. They have designed a plan called the "Compassion Tax Credit." A brief overview of the Compassion Tax Credit follows, based on information provided by the Beacon Hill Institute.

The Flawed Current System

The existing welfare bureaucracy wastes billions of dollars. Estimates vary, but there is little doubt massive sums allocated to assist the poor are wasted by administrative costs. In addition, individual taxpayers have no role to play in the current system. They have no way of knowing what portion of their tax dollars actually reach the needy. Taxpayers also have no power to direct their "contributions" to the most effective public assistance programs. Professional bureaucrats wield all the power in a system long criticized for, in the words of social policy analyst James C. Geoly, "inefficiency, unresponsiveness, and corruption."

Taxpayer-Controlled Welfare

The alternative proposed by the Compassion Tax Credit — and similar reform measures — is striking. Under a tax credit system, taxpayers receive incentives to increase their donations to qualified charities in the private sector. Citizens play a direct role in assisting the poor, rather than merely serving as passive participants in a broken system. The Tuerck/O’Brien plan calls for a 100 percent deduction for donations to qualified charities, up to 25 percent of total federal tax liability.

Gradually, the existing welfare bureaucracy would be replaced by private charities, who operate far more efficiently than bloated state and federal agencies — charity workers, after all, see their work not simply as a profession, but a "calling." And not only would the tax credit system grant a taxpayer control over where his or her dollars are spent, it would "inject much-needed competition into the currently monopolized welfare market." Welfare recipients would be able to "shop around" to find charities that are best able to assist their individual needs.

The Opposition

As one could expect, the radical nature of the compassion tax credit proposal upsets many in the public welfare establishment. As Geoly recently wrote in the Wall Street Journal, "For a consortium of big-government types — welfare advocacy groups, public employees’ unions and the bureaucrats who administer welfare programs — privatization of welfare represents a threat to the influence and power accumulated over the past 60 years. Thus, they do not support welfare reform to begin with, let alone such a revolutionary move." But despite attacks from entrenched interests, charitable choice proposals have piqued the curiosity of many. The Beacon Hill Institute is currently negotiating with several states to implement a Compassion Tax Credit pilot program.

A Real-World Test

While implementation at the federal level is the ultimate goal, a state-based pilot program could be a useful test of the compassion tax credit’s effectiveness. A host state would fund the pilot program by offering a 50 percent tax credit for donations, up to 50 percent of an individual’s state tax liability. Additional revenue would come from the state’s general fund.

The pilot program has six main participants:

The funding source provides the money to run the pilot program;

The oversight organization administers and studies the program’s effectiveness;

Charitable organizations must meet strict criteria to participate in the pilot program. For example, organizations must be classified 501(c)(3) (tax exempt), raise at least $543,750 in donations during the first year and provide clearly-specified services to the poor. "The pilot program will impose little additional costs on the state," say Tuerck and O’Brien, "because recipients who receive assistance under it would have received assistance anyway under existing programs." Family advocates — volunteers working for charitable organizations — would provide recipients with food vouchers, rent subsidies, worker training, and other traditional welfare benefits. Advocates would be recruited from the community and given extensive training.

Conclusion

A system of tax credits for charitable donations would radically change the current welfare system. While the full impact of such a plan cannot be known until it is implemented, a pilot program would provide a strong indication of how effective the system could be on a nationwide scale.

Nevada Governor Bob Miller boasts of a drop in state welfare cases since 1995, but U.S. Department of Health and Human Services figures show that from January 1987 to September 1996, the number of Nevada families receiving Aid to Families with Dependent Children benefits rose 135.3 percent — sthe largest increase in the nation. Nevada legislators should give charitable choice proposals a fair hearing (obviously, Nevada’s lack of a state income tax means a pilot program would need to derive revenue from state funds). By participating in a charitable tax credit program, Nevada could become a national leader in the effort to design a caring and cost-effective welfare system.

D. Dowd Muska is a Research Analyst at NPRI.

An Author of the Compassion Tax Credit Responds to Critics

"The tax credit would cause total assistance to the poor to decrease because the resulting tax-revenue losses would cause government to cut programs."

In fact, the tax credit would give taxpayers a chance to increase the total assistance going to the poor. The reason lies in the greater efficiency with which their tax dollars would be spent when placed in the hands of private charities rather than welfare bureaucrats.

"The tax credit would cause total assistance to the poor to decrease because people who already contribute to the support of the poor would receive an additional unnecessary tax break."

Individual contributions to private charities account for less than 10 percent of all public and private assistance to the poor (provided under means-tested, non-Medicaid programs). This shortfall would be made up in part by the greater efficiencies achieved and by the greater success private charities could be expected to enjoy in ending dependency. If concerns still remain, the law could include a threshold making only new contributions eligible for the credit (letting contributions below the threshold remain eligible only for the existing deduction).

"Money diverted to private charities would ‘leak’ into activities that do not help the poor and would increase administrative costs."

In fact, there is likely to be far less waste and leakage under the tax credit than there is now. By one estimate, only 41 percent of poverty-level families receive any government benefits and some 67 percent of all federal welfare spending ends up in the pockets of the nonpoor.

David G. Tuerck, the executive director of the Beacon Hill Institute, is an economics professor at Suffolk University.